Most European countries have a minimum wage, but what about a “maximum wage”? Should there be a limit on how much companies can pay their employees? Should the highest-paid executives have some sort of cap on their salaries? In fact, some European countries do already place a cap on what public sector employees can earn. Would it be possible to apply something similar to the private sector? Or is the idea itself completely bonkers?
What do our readers think? We had a comment from Christos, who thinks that executives are paid too much right now, not just in absolute terms but also relatively compared to the average salary their workers earn. Is he right?
To get a response, we spoke to Luke Hildyard, Executive Director at the High Pay Centre, a think tank that researches pay at the top of the income distribution. What would he say?
Yes, I think we would agree with that. In the UK – and the trend there mirrors what’s happened in most other advanced economies – a typical FTSE 100 CEO has gone from being paid about 60 or 70 times their average worker’s salary in the late 1990s to closer to 150 times today. There hasn’t really been any corresponding improvement in the performance of executives; there’s not reason to think they’ve become individually more brilliant in relation to their workers over that period. It just seems that they’ve been able to exploit their position of power at the top of companies, and corporate culture has become more tolerant of the pay of those at the top racing away from everyone else. And, of course, the consequence of that is that it leads to much weaker trust in business, a lack of social cohesion, and an increasingly angry and mistrustful society.
This brings us to the comment from Pedro, who argues that wages should be bounded between a minimum and maximum wage, with salaries distributed according to job performance. It seems like a radical policy, but does it make economic sense? And would it be good for society?
To get a response, we put Pedro’s idea to Kevin J. Murphy, Professor at the University of Southern California; Kenneth L. Trefftzs Chair in Finance at the USC Marshall School of Business; Professor of Law at the USC Gould School of Law; Professor of Economics at USC’s College of Letters, Arts & Science. How would he respond to Pedro?
There is a perception – long-held in Europe but growing in the U.S. — that income inequality is a pressing problem calling for government intervention. The importance of, and the solutions to, this perceived ‘problem’ is hotly debated, with some of the debate asking the sensible question of the causes and consequences of inequality. In the U.S. for example, there has traditionally been a tolerance for inequality driven by differences in skills, abilities, ideas, innovation, and entrepreneurship, but an intolerance for inequality created by corruption or power (including the power of monopolies in a non-competitive marketplace). Indeed, Adam Smith taught us that societal wealth is maximised in a corruption-free environment where individuals are free to consume and produce at prices (including the price of labour) determined in a competitive marketplace.
The problem, of course, is that maximising societal wealth rarely allocates that wealth in equal shares across the members of that society. Redistributing that wealth to facilitate more-equal shares inevitably reduces the size of the overall pie to be sliced, and the trick becomes in dividing the pie more evenly while minimising the residual loss.
Setting minimum and maximum wages are a particularly inefficient method of redistributing wealth, since it explicitly taxes individuals with skills, abilities, ideas, innovation, and entrepreneurship. Binding minimum wages hurt society because it creates a class of unemployed individuals who would be eager to work for market-determined wages, but cannot find jobs at the higher minimum wage. Their plight will predictably increase over time, as employers respond by shifting from labour-intensive production technologies to capital-intensive technologies.
Setting maximum wages creates a potentially worse set of problems, which I’ll address in my response below to Bernard.
To get another perspective, we put the same comment to Luke Hildyard from the High Pay Centre. How would he respond?
It’s an interesting proposition, and it anybody suggests it – policymakers, think tanks or campaigners – it’s derided as being unrealistic or extreme. But, if you think about it, what’s really more extreme? The idea of one individual being paid many hundreds of times what an ordinary worker earns, or the idea that their pay should be capped at a mere 20 times? Or 10 times? 10 times the average workers is still a very decent amount of money. It affords a lifestyle far beyond what most people could even dream of. So, it’s not such a crazy proposal, but I think it’s very unlikely that we’ll see any policymakers introduce it anytime soon. I’m not aware of it being given serious consideration in any major economy.
The government could apply a cap in the public sector, it can also use public procurement to drive down pay in the private sector. A great many of these firms benefit from public spending, so you can say: ‘Right, we’re not going to award any more contracts to people unless they distribute their pay throughout their organisation a bit more fairly and proportionately.’ So, that might be a good way of moving towards that without going all the way to a full cap.
Next up, we had a comment from Bernard, who dislikes the idea of a maximum wage, claiming it would be particularly detrimental for entrepreneurs. Is he correct? Would a wage cap deter entrepreneurship and innovation?
How would Professor Kevin J. Murphy respond to Bernard’s comment?
Bernard is absolutely right. Setting maximum wages destroys incentives to work past that maximum wage. In situations where wages are variable (for example, in sales), setting maximum wages creates incentives to shift performance unproductively across periods (for example, by saving some of this year’s production to next year when the cap might be binding).
The worse problem is the ‘brain drain.’ Unless maximum wages are set globally (or even locally across all activities), the cap will not necessarily stifle innovation but rather determine where that innovation occurs. Top athletes and entertainers, more example, have routinely flocked to the U.S. where there are less constraints or implied maximum wages. Top U.S. corporations, saddled with uncompetitively high corporate tax rates, have flocked to Ireland, the Cayman Islands, and other tax havens. Setting implicit caps on European investment bankers have driven a move in top financial entrepreneurs into hedge funds, private equity, or less-constrained overseas markets such as Wall Street, Hong Kong, or Singapore.
Finally, how would Luke Hildyard respond to the same comment? Did he agree that setting a maximum wage across Europe would lead to ‘brain drain’, as the most talented individuals go elsewhere, attracted by more competitive compensation?
Well, I think the risk of both losing so-called ‘talent’ overseas is exaggerated, and hypothetically if it did happen, would it be so dreadful? If you look at what makes companies successful, in some cases there are examples of particularly driven individuals pushing them forward and coming up with inventions and innovations on which the company’s success is built. But I think that in those cases, even, they’re not especially motivated by pay or making loads of money, but by status and responsibility and prestige and the significance of achieving something big. More generally, if you look at the chief executives of the world’s biggest companies, they tend not to be poached from international rivals, they’re much more commonly promoted from within. If you look at those companies, very many of them have got long, established histories, they’ve got thousands of workers, in many cases they depend very much on support either in public spending, investment in research, lobbying on their behalf by different governments. It’s very contestable to argue that their success is entirely based on one individual, or a handful of individuals at the top. I take a much more collective view of success, that it depends on the wider economic context, a healthy public infrastructure in terms of education, transport, energy and whatnot that we have in the west, and most of all on the contribution of all the workers that make up the company staff, rather than just the one or two at the top.
Should executive salaries be capped? We have a minimum wage, so why shouldn’t we have a “maximum wage”? Let us know your thoughts and comments in the form below and we’ll take them to policymakers and experts for their reactions!